By Steven K. Beckner
(MaceNews) – Federal Reserve Vice Chairman Richard Clarida put heavy emphasis Wednesday on the behavior of inflation expectations in determining the proper response of monetary policy as the economy evolves in coming years,
Clarida, whose monetary economics bona fides have made him an influential lieutenant to legally trained Fed Chairman Jerome Powell, said the Fed staff’s index of common inflation expectations (CIE) will be a “valuable” guide in deciding the time and pace of future increases in the federal funds rate.
He suggested the CIE, which is based on 21 different indicators, will be more useful than looking at either TIPS break-evens or survey measures of inflation expectations, and more important than the inflation data themselves, which can reflect such things as “transitory bottlenecks.”
“Other things being equal,my desired pace of policy normalization post liftoff to return inflation to 2% would be somewhat slower than otherwise if the CIE index at the time of liftoff is below the pre-ELB (zero lower bound) level,” he said in remarks prepared for delivery to a Shadow Open Market Committee virtual meeting.
Elaborating in response to questions, he said, “if I were to see that measure drift up persistently (in a way) not consistent with that (2% inflation) goal that would indicate to me that policy needed to be adjusted.”
Clarida said there will inevitably be “a degree of inertia post-liftoff” once the Fed’s rate-setting Federal Open Market Committee raises the funds rate from near zero, and he said the amount of inertia is apt to reflect the degree to which inflation expectations are rising.
“You never take the federal funds rate from zero to X in one meeting,” he said. “There’s always inertia, and to me a very natural way to think about what liftoff looks like, as a function of inflation expectations, is where inflation expectations are at the time you lift off.”
“If they’re close you perhaps have a lower degree of inertia, and if they’re not close – if they’re below – you return to neutral more slowly,” he added.
In accordance with its revised Statement of Longer-Run Goals and Monetary Policy Strategy, the FOMC now aims for inflation “moderately above 2% for some time” to achieve “average” 2% inflation and undertook to “mitigate shortfalls” of employment from maximum levels . It also said maximum employment must be “inclusive.”
Expounding on that new monetary policy framework, which the Fed unveiled last August and implemented at subsequent meetings, Clarida said the FOMC will not be raising rates or reducing asset purchases just because unemployment is falling, but will be keenly watching inflation and inflation expectations.
He said he and his colleagues will also be keeping a close eye on wages, because “in any modern economy, to get a sustained increase in inflation you need to get a sustained increase in wages….”
Clarida said the FOMC will “take into account persistence” of wage-price pressures.
Monitoring inflation expectations will provide “a reality check” on whether labor markets are getting too tight, he said.
Clarida did not comment on the behavior of market-based measures of inflation expectations, such as the spread between yields on five-year Treasury notes and Treasury inflation-protected securities of the same maturity. The five-year “breakeven” has jumped from 1.98% at the start the year to 2.55% recently.
Regarding asset purchases, Clarida said a decision to reduce their pace will be done “prior to any decisions about lifting off.”
Echoing the March 17 FOMC statement, he said he and his fellow policymakers “want to see substantial further progress toward our dual mandate objective before we slow the pace of purchases… It’s going to be outcome based…”
Clarida was upbeat about the economic outlook, saying he’s looking for “potentially the fastest growth in 35 years,” but he said risks remain. And he stressed, “we want to see actual progress” – not merely forecasts.
Earlier, Powell seemed to amplify his own optimism about the economy, saying it seems to be “at an inflection point.” Citing the strong March jobs report, he told the Washington Economic Club, “I think we’re going into a period of faster growth and higher job creation,”
But he also stressed “there are still risks,” in particular a continued virus threat, that “we have to be careful about.”
So, Powell suggested the FOMC is still far from firming monetary policy: “We would expect to keep interest rates where they are today until three particular outcomes are achieved in the economy. The first is that the recovery in the labor market is effectively complete. The second is that inflation has reached 2%…and really reached it, not just sort of …. but has reached it sustainably. And the third thing is that inflation is on track tor run moderately above 2% for some time. Those are the tests.”
“So, we are really focused on the progress of the economy toward those goals and not on a particular time frame,” Powell continued. “When we get those three boxes checked that’s when we’ll consider raising interest rates, and that’s when we will raise interest rates. Until then we won’t.”
Powell reiterated the Fed will only consider tapering asset purchases “when we’ve made substantial further progress toward our goals, from last December when we announced that guidance. And that, in all likelihood, would be before — well before – the time we consider raising interest rates….”
Meanwhile , New York Federal Reserve Bank President John Williams downplayed inflation risks and said the economy still has far to go to achieve the Fed’s goals.
Collectively these comments from the top three Fed officials strongly suggest the FOMC will leave in place the aggressively expansionary policies it has been following for the last year when it meets in a couple of weeks.
At its last meeting, the FOMC left the federal funds rate in a zero to 25 basis point target range and said “it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2% and is on track to moderately exceed 2% for some time.”
The FOMC also said it would continue buying $120 billion of bonds per month “until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.”